October 30, 2009

On Wednesday, October 21st, the Securities and Exchange Commission (SEC) held an open meeting in Washington, DC to address what it perceives as a growing lack of market transparency with respect to non-displayed venues and the emergence of a "two-tiered" market structure in which in which the public is deprived of information and denied access to liquidity available to institutional traders. At that meeting, the SEC put forth a series of proposals it believes will enhance transparency, reduce asymmetries, and enhance public confidence in the equity markets.

The SEC put forth several proposals for comment including: 1) “Actionable” indications of Interest (IOIs) should be subjected to the same disclosure rules as displayed market quotes; 2) the "Fair Access Rule" volume threshold (the threshold at which point an alternative trading system (ATS) must publicly display quotes in a security and make the quoted liquidity publicly accessible) should be reduced from its current level of 5% to 0.25% of average daily volume and 3) ATSs should be subjected to the same post-trade information disclosure requirements as exchanges by amending existing rules to require real-time disclosure of the identity of a non-displayed venue that executed a trade.

These proposals were raised verbally at the meeting and the SEC has yet to present them in writing. Unfortunately, discussing these proposals in advance of releasing them in written form has raised significant confusion in the industry. Woodbine Associates has received several calls from individuals who were present at the meeting yet took away different (and in some cases) conflicting points on the various discussion topics.

We analysts at Woodbine Associates realize we are taking a bit of a leap of faith in putting forth an opinion piece with so much uncertainty surrounding the SEC’s views and intentions. However, we believe that certain points are clear: attention on the growing market share of non-displayed venues has raised concern over efficient security pricing in the open market; in the wake of the Flash Order debate, there are concerns that indications of Interest (IOIs) may give an unfair advantage to groups of traders in the open market; and there are increasing concerns that non-displayed venues are “too dark” in that they are under no obligation to make fully available the securities and share quantities they execute on a post trade basis.

In short, we believe that that the IOI issue was left too broadly defined and we are not sure of the SEC ultimate intentions, so we have refrained from putting forth an opinion at this time. In regard to the quote threshold, we believe that if price discovery in the open market is the predominant concern, a better solution would be to keep the quote threshold at 5% but prohibit all non-displayed trading in all venues for the remainder of the trading session once the threshold is exceeded in any one venue.

We also believe that post-trade disclosure would be useful and not detrimental to non-displayed block venues, though there might be an adverse effect on venues that provide open access to algorithms and electronic trading.

Please feel free to download and read the full Woodbine Opinion from our website here: Early Thoughts on SEC Proposals to Strengthen Regulation on Dark Pools.

About the Author

Matt Samelson is a Principal at Woodbine Associates, LLC, specializing in equity market structure, trading venues, electronic trading, and transaction cost analysis. He has a wealth of experience in U.S. and international equity sales and trading, quantitative analysis, consulting, and research. He has in-depth knowledge of trade strategy formulation, algorithmic trading, market structure, transaction cost analysis and trading technology.